As the prime contractor for the US Government, Lockheed Martin (NYSE:LMT) leads the global defence industry as being one of the forefront companies involved in research, design, development, manufacture, integration and sustaining of advanced technology systems and products for defense, space, intelligence, homeland and cyber security. For investors, its ability to secure returns is what makes the difference.
For 11 years, LMT has provided returns to investors in the form of increasing dividends. It has delivered an annualized total return of 13.80% over the last decade. Will it be able to sustain it? Do its future prospects make it an attractive investment? The answers to these questions depend on LMT's future strategy and the external factors acting upon it.
Dependence on the US Government
The viability of LMT is directly dependent upon the budget and strategic policy of the US Government. In 2012, the US Government accounted for 99 percent of LMT's $47 billion revenue, either through direct contracts or a sale to the foreign military through contracts with the US Government. Beginning on 1st March 2013, the Budget Act plans to reduce defense spending by $500 billion over a nine-year period. This could well damage LMT in the future as the defense cuts would result in lesser sales and a potential decrease in operating margins as LMT struggles to cope with its high overhead and research costs.
Impact Yet to Hit
Despite the tightening conditions, LMT has not yet faced the impact of the US crisis as it reported improvements in some if its segments and their performance in the third quarter of 2013. While Aeronautic and ISGS segments remained relatively stable over the term of performance, MFC and MST segments showed improvement as operating margins jumped to 17.8 and 12.8 percent, respectively. On the other hand, Space Systems showed a decline, with margins falling due to a decrease in sales.
Discussing the segments that showed improvements, MFC was able to increase its sales by 3% owing to a higher sales volume of THAAD and PAC-3 programs. On 23rd September 2013, LMT entered into a $3.9 billion contract to provide 110 THAAD to the US Army and UAE. This pushed the sales even higher. Since the contract will be valid till the fiscal year 2014, it will further improve margins in the coming year.
MST also reported an increase in margin even though sales revenue fell due to decreasing volume. The improvement in results was due to more risk retirements of $35 million. Like MFC, MST did not improve its margin by increasing sales or improving cost efficiency, therefore depriving the company of any future expectations regarding improving margins. This segment gained only via a one-time cost reduction.
The only segment that declined was SS (Space Systems). SS margins fell due to a common factor of decreasing demand. In addition to that, SS received less income from joint ventures due to lower launch related activities and discussions over cost matters, which delayed decision making.
Investments and Deals to Cushion
Last month, LMT announced the acquisition of Amor, a private IT firm in order to expand internationally and tap into non-defense markets. The acquisition will allow LMT to expand its capabilities and expertise in IT, civil government and energy. Combining Amor's airport operations business, which is in use at more than 75 airports worldwide, with Lockheed air traffic solutions business would create a larger and more effective business, according to Lockheed spokeswoman Jennifer Allen. With US spending cuts coming in the future, LMT's move to diversify into other markets was a smart step. IT and energy are on the rise and tapping this market will allow LMT to sustain current margins and value for its shareholders in the future.
In addition, LMT could well benefit from the potential South Korean arms deal. According to Reuters, political pressure to meet budget deadlines in South Korea to deliver 5th generation war planes by 2017 means that LMT could receive an order of 60 planes by next month, promising billions in revenue. In a statement by South Korean officials, it was referred that South Korea plans to buy planes that are capable of not being seen under radar, a current capability of LMT's F-35 that is not offered by its rival Boeing (BA), another candidate trying to win the bid. This implies that LMT is a good chance of winning this tender. This tender will directly affect margins in the future and allow investors to receive higher dividends, if LMT chooses.
LMT announced this month that it will consolidate several of its US facilities and reduce its workforce by 4,000 due to the spending cuts. This will improve LMT's efficiency and make its products more affordable. These measures were in line with the company's future work projections. LMT will reduce nearly 2.5 million square feet of its workspace hence decreasing overhead costs. The recent government cuts have promoted LMT to adopt these measures and they will help LMT in retaining investor value for the future.
LMT is set to become more powerful in the defense industry with its Long Rage Anti-Ship Missile (LRASM). After the first trial conducted in August, it successfully passed its second trial demonstrating its capabilities and effectiveness. The missiles offer a new spectrum of demand for sea missiles which could affect the profitability of LMT given its value to global navies.
Not only that, the Javelin Joint Venture between LMT and Raytheon received $176 million in September to produce and deliver 842 Block I Javelin missile rounds and 120 command launch units (CLUs). The units will be delivered starting in October to the U.S. Army and Marine Corps as well as three international customers: Oman, Jordan and Indonesia.
What about F-35?
Another major product under development is the fighter aircraft F-35. The F-35 is making progress, and there's reason for investors to be hopeful especially since more and more countries are interested in purchasing the F-35. However, there are also a number of issues that still need to be addressed. The Quality Assurance Assessment report released by the Inspector General on September 30 said that the F-35 has a number a major issues that could adversely affect aircraft performance, reliability, maintainability and ultimately program cost. More pointedly, the report found 362 findings which contained 719 issues.
Despite It being 70% over budget and years behind schedule along with the difference between different US departments on the costs their offices will suffer for the operating and maintenance of F-35, it is unlikely that the program will be drawn away by the US government in the future as the Pentagon estimates $392 billion of expenditures for 2,443 aircraft in the coming decades.
NASA's Mars Atmosphere and Volatile Evolution (MAVEN) spacecraft, built by Lockheed Martin, was successfully launched this month. The process went smooth and accomplished LMT's research objectives. The handshake with NASA emphasizes LMT's visible strong presence. I believe such a strong political stance makes LMT powerful and with a sound standing. With LMT and Reignwood Group signing another contract to start design of a 10-megawatt Ocean Thermal Energy Conversion (OTEC) power plant, which, when complete, will be the largest OTEC project to date, there is no doubt for investors to gain in this defense giant.
Coming to an annual analysis, LMT has performed relatively well than its competitors and the industry and is expected to do so in the future. LMT's forward P/E ratio is less than its trailing P/E ratio compared to its rival Northrup Grumman's (NYSE:NOC) that has a forward P/E ratio greater than its trailing P/E. In terms of dividend yield, taking this year into account, LMT has outperformed by yielding 4% as compared to the rival Northrup Grumman's yield of 2.3% and the industry's 2.4% dividend yield.
Strong performance indicators accompanied with investments and future deals in hand, the rise in stock price for the last year is well justified. LMT has experienced a 43% increase in its stock price and I expect this trend to continue.
Candy for Investors
With plans to open subsidiaries in Israel, potential business in the IT and energy sector along with orders from Netherland, Britain, Italy, Australia and Japan, there is no doubt that LMT holds potential rewards for its shareholders. Despite government cuts, LMT is determined to hold its value by already planning to diversify. Forward performance is expected to be better than rivals and the industry taking into account its fundamentals. One should consider LMT if he/she desires to earn returns in short term through price appreciation and a stable dividend.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.